Under the darker than expected shadow of unsold condos and single- family homes coming back as rentals, two of the country’s largest apartment REITs have lowered full-year earnings guidance from the sunny predictions at the beginning of the year to less optimistic forecasts as the softness that appeared in a number of markets last spring turned into a monster, gobbling up considerably more renters than expected.
Both Camden Property Trust and Equity Residential have major exposure to markets burdened by unexpectedly large supplies of unsold for-sale housing.
Equity Residential (EQR) reduced full-year same-store revenue guidance mid-year to 3.75 to 4.25 percent from the former range of five to six percent. At the beginning of the REIT’s Q2 earnings call EQR CEO David Neithercut blamed “the continued drag on our performance by those markets most impacted by condo development and reversions, as well as high single-family home inventory” for the lowered expectations, listing the Florida markets, Washington, D.C., Phoenix and California’s Inland Empire as the company’s markets most affected by competition from unsold single-family homes and condos.
Camden Property Trust, which has an even bigger exposure than EQR to markets with an abundance of homes and condos for rent thanks to its 8,064 units in Las Vegas, started the year with expectations of net operating income (NOI) growth of between 5.5 and 7.5 percent, but, by Q3, was projecting full-year same-store NOI growth of between 4.5 and five percent, and same-store revenue growth between 4 and 4.5 percent.
“Overall, earnings growth for the quarter was in line with our expectations. Same property revenue and net operating income growth were not. Pricing power declined across many of our markets, primarily as a result of increased competition from single-family home rentals,” Camden CEO Ric Campo explained during the REIT’s Q3 earnings call. “While the magnitude of the oversupply in the single-family rental markets is hard to get your arms around and varies by market, we know that apartment demand is being muted by increased rental home competition. How long this situation lasts is a much debated topic,” Campo said.
Reviewing current market conditions, Camden COO Keith Oden predicted that the decelerating revenue growth will continue into Q4, carrying on a trend that started in Q2, when two of the REIT’s six operating regions fell short of plan, followed by five in Q3 and, in the company’s most recent re-forecast, completed as part of the 2008 budget process, NOI is expected to fall short of original budget in Q4 in all six of the operating regions in the REIT’s 64,500-unit portfolio that stretches from coast to coast.
Oden identified two culprits that are causing the expected decline, citing the continued deterioration in the single-family home market that is bringing more home rentals into competition with apartments in all 15 of Camden’s core markets, which include metro Washington, D.C., Las Vegas, Tampa, Southeast Florida, Orlando, Phoenix and San Diego, the hardest hit by the oversupply of condos and single-family homes that aren’t selling, thanks to the tightening of credit standards following the subprime mess.
“This condition will continue as a headwind for multifamily until the inventory of unsold homes begins shrinking. Based on the most recent projections of new home completions versus sales, the inflection point will likely occur in the middle of 2008,” Oden predicted.
And it’s interesting to note, he said, that the company’s move-outs to home purchase fell to 17 percent in Q3, the lowest level the REIT has seen in three years. In addition, in Q2, Camden started tracking the percentage of move-outs to home or condo rentals, which accounted for less than one percent of total move-outs.
“If you combine this with the fact that our overall traffic was down nine percent over the prior year, you get some statistical data that supports the anecdotal evidence from our operations group that a meaningful amount of would-be renters are bypassing the multifamily options in favor of other options, most probably single-family rentals,” he said.
“The second culprit is the declining employment growth forecast. From last quarter, the employment growth numbers were revised downward for 2008 in 14 of Camden’s 15 markets, with Raleigh as the only upward revision. In the aggregate, the employment growth forecast for Camden’s markets was revised downward by 143,000 jobs, or about 25 percent, leaving the revised job growth forecast for Camden’s markets at around 375,000 for 2008,” he said, adding that the jobs picture appeared to be brightening a bit as the year comes to a close and there might be a welcome upward revision for next year.
Oden speculated that Camden’s slow-down in revenue compared to its peers also was a function of the forward-looking model that YieldStar, the REIT’s Web-based revenue management system, applies to market rents. Camden is the only publicly reporting multifamily company that has been using a revenue management program since this current rent growth cycle began in around Q1 2005.
YieldStar attempts to anticipate market conditions five to six months out. “As markets begin to recover and pricing power improves, the forward-looking nature of the pricing engine would raise rents sooner than our competitors,” he said, noting that the facts seem to support the theory. From Q1 of 2005 through the second quarter of this year, Camden experienced the second highest cumulative revenue increase of all the apartment REITs, achieving larger rental increases sooner than its competitors.
Oden believes the revenue slowdown of Q3 is consistent with a revenue management tool that is attempting to get ahead of the curve of a slowing market. “It will be interesting to see what happens in the next two quarters regarding the revenue growth rate of us and our competitors,” he said, adding that, if the other REITs don’t begin to experience the slowdown that Camden currently is pricing into its rents, the company will seek other remedies for its relative under performance.
In the meantime, as Oden explained in the company’s Investor/Analyst Day presentation last fall, Camden’s focus this year is on things the company can control, like the other income, along with reduced property management and operating expense, that Camden CFO Dennis Steen said in Q3 balanced out the $1.1 million or 0.9 percent unfavorable variance to the company’s same store revenue expectations for the quarter
It’s not possible to control the disruption in the company’s markets that stems from a slowdown in job growth or an increase in the number of for-sale homes and condos transformed into competitors for rent or the possibility of a recession that could result in resistance to rent hikes, so Camden is looking inward, trying to maximize the NOI from its existing portfolio through various revenue initiatives like its Perfect Connection and Valet Waste programs, while implementing expense controls and operating efficiencies that will pay dividends for years to come, allowing the company to carry on profitably, regardless of the operating environment, Oden said.
“This is a nickel-and-dime business and, in many ways, it gets down to whether you can satisfy your customer, create a great customer experience and, at the same time, manage and limit cost increases,” he said.
Perfect Connection is a perfect example of that kind of program. It was launched in October 2005 at two communities acquired in the company’s merger with Summit Properties earlier that year–the 400- unit Camden Ballantyne in Charlotte and the 354-unit Camden Westwood in Morrisville, N.C., just outside of Raleigh. The test program was well-received, said Linda Willey, Camden’s director of property services.
By last spring, 71 Camden communities were participating in the program and that number increased to around 35,000 units in 104 communities by September, with an additional 17 communities being launched in Q4.
“We’ll launch 23 communities in the first quarter of 2008, which will put us at a total of about 50,000 apartments participating in the program,” said Oden, adding that profit for the month of August alone was about $470,000.
“We purchase it in bulk and, at a number or our communities, will turn on every single unit, so the unit’s hot and active when the resident moves in. The nice thing is that the resident could do a quick lease and move in that same day and plug in their television set and watch American Idol that night,” Willey said.
While participation in the program is required of all new and renewing renters at communities where it is offered, it’s not a requirement that raises many objections. Quite the opposite, she said. “There are no installation fees, no waiting on the cable guys, and rates are significantly lower than what you would pay the underlying cable provider and it’s good for the lease term,” she said.
“This is an incredible and very compelling example of value-add to the residents. Our residents actually get the same cable offering at a lower price than they were paying the incumbent provider,” Oden agreed.
In Houston, where the tax and franchise fees for a subscription to Time Warner’s cable service probably would run around $50, several of Camden’s communities offer the same service for $40, which is included in the rent payment. “Typically, people have been able to say it’s at least a savings of $5 to $10 per month, but, in some areas, depending on what we’re charging and what they could have gotten from the underlying provider, they can save up to $200 a year,” said Willey.
“It’s been phenomenal,” she said of the program. “It’s seen as a huge benefit to the residents, because perhaps they couldn’t afford, when they first moved in, that extra couple hundred dollars for the deposit. But now, by simply signing a cable TV addendum, they erase that.”
“The renter gets a break on the price end and we make a significant margin over the bulk rate, so it’s a win-win for everybody in the program,” Oden said.
About a month earlier, during the company’s Q2 earnings call, the COO told analysts that the original business plan for rolling out Perfect Connection assumed that, by the end of this year, Camden would have 31,000 of its units on the program, with an annualized profit contribution of approximately $6 million. But, thanks to the efforts of the company’s business services group and on-site teams, probably closer to 41,000 apartments are expected to be participating by year- end, with an annualized profit contribution in the $7 million to $8 million range.
“The program, when implemented, adds approximately two percent to top- line revenue growth. When you combine this with the two to 2.5 percent that we can achieve from YieldStar, it means that Camden can add four to 4.5 percent revenue enhancements to any asset that we buy or develop. It is crucial in this low-cap-rate environment that as operators we’re capable of adding value to real estate the old- fashioned way–by growing cash flow,” Oden said.
The only upset might have been by the Federal Communications Commission (FCC). The commission’s October 31 ban on exclusive access contracts between video providers and operators of apartment communities and other commonly managed real estate developments, had some pundits worried. But, those worries turned out to be unfounded. In fact, the ruling won’t negatively affect Camden’s Perfect Connection program and may even benefit the company in a few isolated instances.
“Based on our discussions at the FCC’s meeting and press conference on Oct. 31, and written statements of FCC commissioners and their news release, we understand the following,” Oden said. “The FCC ruled that existing and future exclusive access arrangements for video services and agreements between apartment owners and cable companies are unenforceable. Bulk service arrangements, such as Camden’s Perfect Connection, are not in any way affected by the ruling,” he said, adding that one commissioner expressed substantial support for bulk service arrangements.
“The ban is limited to exclusive access, which is defined as a grant of rights provided through an easement or license to a video service provider to exclusively provide cable services, utilize the cable system and market service to residents in the community. Camden is a party to three such agreements, and this ruling will actually allow us to pursue more favorable agreements on those three communities.
“Exclusive marketing agreements were also not affected by the ruling, although the FCC did indicate that it would seek comment in the future on whether it should take any action on bulk or exclusive marketing arrangements. The immediate impact is a slight positive to us and we believe there is minimal risk to our cable revenue in the foreseeable future,” he said.
Camden’s Valet Waste program that provides door-to-door trash pick-up five days a week for the company’s residents was rolled out at 26,000 apartments over 69 communities by last summer with another 22 communities scheduled to be launched in Q4.
“The net profit from this program in what we’ve got rolled out today was about $40,000 for the month of August alone and, we think the program, when it’s completely rolled out throughout our portfolio, will represent about a $2 million profit contribution by 2009,” Oden said in September.
The REIT also is working on enhancing revenue through improved collections processing and controlling expenses and improving operating efficiencies through online programs for recruiting, leasing and marketing, check scanners and online rent payment, electronic signature and document management, JD Edwards accounting platform upgrade, consolidation of waste management, a vacant unit utility billing program and other initiatives that involve purchasing programs and product standardization via Web-based systems.
And, as the market changes, the company is taking advantage of even the subprime debacle by marketing specifically to those unfortunate homeowners who are facing a foreclosure, which will be an issue in more and more of Camden’s markets going forward, if the company’s view of what is going on in the single-family housing markets continues to unfold, Oden said at the beginning of November.
“Right now, that program is actively engaged in Las Vegas and Tampa, which are probably two of the more challenged markets with regard to single-family inventory. But, I would expect that, as the foreclosures pile up in some of these other markets, it is going to be an initiative that we’re going to utilize there, as well,” he said.
“We are constantly seeking ways to make sure that we are at the forefront of marketing our communities and, now, more than ever, is the appropriate time to be doing those kinds of things,” said Oden.